Monetary Policy and the Transmission Mechanism in Thailand By Piti Disyatat Pinnarat Vongsinsirikul

Motivation Understanding transmission mechanism key to successful conduct of monetary policy –Time lag –Channels of transmission Compare with evidence from other countries How has the crisis affected monetary transmission?

Presentation Outline The main channels of monetary transmission Interest rate pass-through Response of key macro-variables to monetary shocks Relative importance of each channel Summary and conclusion

Central Bank Output and Inflation S-T Interest Rate OMO Monetary Transmission Mechanism Transmission Channels Interest Rate Credit Exchange Rate Asset Price

Interest Rate Pass-Through To Retail Rates Methodologies 1.Dynamic Multiplier Model 2.Error Correction Model (ECM)

89M1-95M12 89M1-02M PeriodImpact Immediate 89M1-95M12 89M1-02M Month6-Month Long-Run Speed of Adjustment ECM Methodology Multiplier Method Pass Through of RP to 3-Month Deposit Rate

89M1-95M12 89M1-02M PeriodImpact Immediate 89M1-95M12 89M1-02M Month6-Month Long-Run Speed of Adjustment ECM Methodology Multiplier Method Pass Through of RP to Minimum Lending Rate

International Comparison of MLR Pass-Through

Justification for Interest Rate Stickiness in Thailand High switching cost during economic downturn and fewer alternative sources of funds Credit rationing due to asymmetric information High liquidity Social pressure Posted rate

Response to Monetary Shocks Time lags Channels of transmission

Methodology Vector Autoregressions (VARs) analysis –Dynamic system of equations –Minimal assumption about structure of economy –Evidence for other countries readily available RP14 indicator of monetary policy Sample: 1993 Q1 to 2001 Q4

Basic Model: GDP, CPI, RP14: 2 Lags U-shaped output response, maximum impact after 4-5 quarters

Components of Aggregate Demand Private Consumption Investment Export Import

Channels of Monetary Transmission Augment basic model with variable that represents each channel Compare output response with and without the relevant channel operating

Heavy reliance on bank finance in Thailand Private credit to GDP ratio (average for ) Bank Lending Channel

Bank Lending Model GDP response larger LOANS fall after 3 quarters PRICE falls after 4 quarters

Bank Lending Channel

Credit intensity of production has fallen Re-estimate over 1993 Q1 to 1999 Q1: Impact of RP14 on GDP and LOANS larger Impact of LOANS on GDP larger

Bank Lending Channel: 1993 Q Q1

Exchange Rate Channel

Asset Price Channel

Direct Interest Rate Channel

Summary Model

Conclusion Stylized Facts (In Response to a Tightening): 1.GDP displays U-shaped response, trough after 4-5 quarters and dissipating after 11 quarters 2.GDP displays U-shaped response, trough after 4-5 quarters and dissipating after 11 quarters 3.Investment most sensitive component of GDP

Conclusion (cont.) Transmission primarily through interest rate and bank lending channels Role of banks declined in recent years - Lower interest rate pass-through - Weaker bank lending channel

Looking Forward Bank health and corporate balance sheets More sensitivity of retail rates Wider share ownership Greater access to credit: Financial Master Plan Resolution of FIDF problems

Implications for Monetary Policy Significant lags involved in monetary transmission These lags change over time Must be forward-looking – Rely on accurate forecasts – Constantly look out for structural changes in the economy